TOPIC
Taxation of Cryptocurrency and Other Digital Assets
Last Updated April 3, 2023
Transactions involving virtual currencies (e.g., cryptocurrency), non-fungible tokens (NFTs), and other forms of digital assets continue to be of significant economic interest in recent years, both in the United States and around the world, because of the billions of dollars in unreported income annually in digital asset transactions.
Not all digital asset transactions are taxed equally. In fact, the lack of clear tax rules is causing confusion for taxpayers. Inconsistent tax treatment among the various types of digital asset exchanges makes it difficult to correctly report digital asset transactions.
Bloomberg Tax provides expert guidance to help you navigate the complex issues involved with the taxation of digital asset transactions at the federal, international, and state levels.
The basics
Digital assets are taxed as property
Digital assets are defined as digital representations of value that are recorded on a cryptographically secured distributed ledger. Popular digital assets include NFTs and virtual currency, like cryptocurrency.
Because digital assets are treated as property for federal tax purposes, general tax principles applicable to property transactions apply to digital asset transactions. If a particular asset has the characteristics of a digital asset, it will be treated as a digital asset for federal income tax purposes.
Digital asset adjusted basis
Generally, your basis (also called cost basis, adjusted basis, or purchase price) is the amount you paid for the digital asset, including transaction fees and other acquisition costs, in U.S. dollars. Also, your basis is increased by certain expenses and decreased by certain deductions or credits to arrive at your adjusted basis in the digital asset.
You need to know your adjusted basis in your digital asset because if you sell, exchange, or otherwise dispose of any financial interest in your digital asset, you will need the adjusted basis to determine the gain or loss you may realize from the disposition.
Also, if someone gifts you virtual currency and you later sell or exchange it, your basis in the gift differs depending on whether you will have a gain or loss when you dispose of it. To determine whether you have a gain, your basis is equal to the donor’s basis, plus any gift tax the donor paid on the gift. To determine whether you have a loss, your basis is equal to the lesser of the donor’s basis or the fair market value of the virtual currency at the time you received the gift.
Virtual currency as payment
When you receive property, including virtual currency, in exchange for performing services – regardless of whether you perform the services as an employee or independent contractor – you recognize ordinary income. The amount of income you must recognize is the fair market value of the virtual currency, in U.S. dollars, when received. Your basis in the virtual currency you received is the fair market value of the virtual currency.
Selling or exchanging virtual currency for property
If you exchange virtual currency held as a capital asset for other property (e.g., goods or other virtual currency), you will recognize a capital gain or loss. Your gain or loss is the difference between the fair market value of the property you received and your adjusted basis in the virtual currency exchanged. Your basis in the property received is its fair market value at the time of the exchange.
Exchanging virtual currency for services
If you pay for a service using virtual currency that you hold as a capital asset, then you have exchanged a capital asset for that service and will have a capital gain or loss. Your gain or loss is the difference between the fair market value of the services you received and your adjusted basis in the virtual currency exchanged.
Download: Taxation of Cryptocurrencies (Portfolio 190) Executive Summary
This complimentary executive summary provides important insight about the federal income taxation of crypto.
Reporting rules
Generally, all digital asset transactions must be reported to the IRS.
If a particular asset has the characteristics of a digital asset, it will be treated as a digital asset for federal income tax purposes.
Reporting digital asset transactions on Form 1040
Taxpayers filing any type of Form 1040 for the 2022 tax year must answer the following question: At any time during 2022 did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, gift, or otherwise dispose of a financial interest in a digital asset?
Generally, you have a financial interest in a digital asset if you are the owner of record of a digital asset or have an ownership stake in an account or wallet that holds one or more digital assets.
For the 2022 tax year:
- If you disposed of any digital asset, which you held as a capital asset, through a sale, trade, exchange, payment, gift, or other transfer, use:
- Form 8949 to calculate your capital gain or loss and report that gain or loss on Schedule D (Form 1040); or
- Form 709 in the case of gifts.
- If you received any digital asset as compensation for services or disposed of any digital asset that you held for sale to customers in a trade or business, you must report the income as you would report other income of the same type (e.g., W-2 wages on Form 1040 or inventory or services on Schedule C).
Infrastructure Investment and Jobs Act regulations
New broker reporting rules on digital asset transactions that were created by the Infrastructure Investment and Jobs Act will not apply until the IRS issues new final regulations clarifying and expanding those new laws.
Until the IRS issues the new regulations, a broker may continue to:
- Report gross proceed and basis as required under existing §6045 law and related regulations.
- Issue statements on transfers of covered securities as required under existing §6045A laws and regulations.
Download: Special Report on Latest Tax Implications on Cryptocurrency
This special report provides insight into recent international developments and issues of note when it comes to the classification and taxation of cryptocurrencies.
IRS guidance
Charitable deduction for donated cryptocurrency
The IRS denied a taxpayer’s charitable deduction for donated cryptocurrency because the taxpayer failed to meet the qualified appraisal requirement and the reasonable cause exception.
Generally, for a §170 charitable donation deduction of more than $5,000, a “qualified appraisal” must be obtained unless the reasonable cause exception applies. The IRS ruled that the taxpayer’s use of the value reported by a cryptocurrency exchange on which the donated cryptocurrency is traded meets neither the qualified appraisal requirement nor the reasonable cause exception.
Loss deduction for worthless or abandoned cryptocurrency
The IRS denied a taxpayer’s loss deduction claiming that its cryptocurrency was either worthless or abandoned because it had substantially declined in value.
Section 165 provides a deduction for losses that are evidenced by closed and completed transactions, fixed by identifiable events, and actually sustained during the taxable year. The IRS ruled that the cryptocurrency was not worthless because it was still being traded on a cryptocurrency exchange and the taxpayer made no affirmative act to abandon the cryptocurrency.
Download: Practitioner Perspectives on Cryptocurrency and Digital Asset Taxation
This special report provides insight into recent international developments and issues of note when it comes to the classification and taxation of cryptocurrencies.
Other jurisdictions
Federal vs. state vs. international cryptocurrency laws
At the federal level, digital assets, like crypto, are considered property and taxed accordingly.
At the state level, however, crypto taxation brings with it another important consideration: sales tax. Is the sale of crypto subject to local sales tax? Most states, in fact, as yet have no guidance or legislation on the subject. Of the few states that do, some, such as California and Kentucky, treat crypto as equivalent to cash in transactions, and tax it according to the same standard. In other states, such as Arkansas and Washington, digital currencies aren’t subject to taxes.
At the international level, there is very little established guidance on whether owners of crypto need to fulfill reporting requirements – this area is developing and evolving. It’s generally recognized that U.S. citizens, residents, and others subject to U.S. tax laws must file a Foreign Bank Account Report (FBAR) for any financial account outside the U.S. whose maximum value exceeds $10,000 at any point during the previous calendar year. As of year-end 2022, foreign accounts which hold only virtual currency are not yet required to be included in an FBAR; however, it is expected that this rule may change in the near future.
Cryptocurrency Tax Laws by State
Get a complete state-by-state breakdown of cryptocurrency tax laws at a glance.
Stay ahead of digital asset taxation developments
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Digital Assets Watch
Quickly access key analysis, news, and other practice tools and resources designed to help you educate and guide your clients on the taxation of digital assets transactions on the federal, state, and international levels.
Tax Practice Guide
This practice guide summarizes tax key concepts and issues practitioners can face in transacting with digital assets, including reporting requirements.
Portfolio 190-1st: Taxation of Crypto
This portfolio considers the nuances of federal income tax laws for digital cryptocurrencies like Bitcoin.
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